Dear Out of State Investors – We Told You So

Austin Foreclosures by California OwnersToday’s Austin Statesman has an interesting, if not predictable article about California investors being disproportionately represented in Austin area foreclosures. We’ve participated in several sales by California investors (not ones that we sold to though) bailing out, some of which were short sales or pre-foreclosures.

As the Austin real estate market rebounded at the end of 2005 and through 2006 and the first part of 2007, Sylvia and I were deluged with calls from investor prospects, mostly from California, wanting to invest in Austin real estate. We were careful in screening those buyers. We never departed from our philosophy of sticking “closer in” rather than chasing better cash flow to the outskirts. As stated on the Investing in Austin page of our website;

Our approach to investing seeks to do more than simply help you buy or sell a rental property in Austin. We have some specific ideas and values about the manner in which real estate investing should be approached, and the effects it can have on neighborhoods and the greater Austin Community. If you agree with our viewpoint, we want you to consider working with us.

Mainly, we do not wish to participate in the mass caravan buying approach that other real estate agents have implemented in Austin in recent years. We don’t think riding in a bus full of other investors out to a new home neighborhood where you buy what your “real estate investing club” tells you to buy is very smart. This approach results in the overselling of homes in many of the new subdivisions around Austin. Especially in the “starter home” areas that young families and first time buyers can afford.

We think you should spend a little more money and buy a better home in an area that less enlighten, short-sighted investors stay away from. Or consider purchasing your investment property in a mature and established neighborhood. While other investors are looking for the cheapest homes with the best cash flow, you should be looking at the neighborhoods with better appreciation potential, where the homes are well cared for, or the area is undergoing a renewal.

The above is verbatim what we’ve told investor since 2005 when we started working heavily with real estate investors buying in Austin.

How did we do?
Were we right in holding this viewpoint?

This philosophy of ours eliminated a lot of potential clients who would have been easy sales for cheap homes in Pflugerville, Round Rock, Hutto, Kyle, etc.  We left a lot of potential sales and commissions on the table by turning away misguided buyers who wouldn’t agree with us on where they should buy rental property in Austin.

What happened to those investors who disagreed with our long term approach and found other Realtors to work with? Let’s look at an example quote from the Statesman article:

Maricel Ruzol, a Las Vegas registered nurse, took one of the tours in 2005 and bought an 1,800-square-foot ranch home in Pioneer Crossing, a Round Rock subdivision. She put 5 percent down and got two mortgages — both at subprime rates — for $151,600.

But it was harder than she had expected to find tenants, and the property taxes, much higher than in Nevada, shocked her. When a renter’s washing machine malfunctioned, causing water damage, Ruzol said, she could not afford the repairs.

Even after getting a second job, “I can’t afford to pay the mortgage anymore,” she said. “Those houses were nice, and they were really cheap, but they didn’t explain the property taxes to us. And they are too much.” The bank foreclosed on the home this month.

Shame on all the Realtors who were more concerned with making sales than they were educating buyers. Real estate investing is very, very risky. We tell potential investor clients that they need to think long and hard about whether or not they can weather to potential downside – the worst case scenario – of investing in real estate in Austin.

This investor, in the example above, was not properly educated, which means she was not painted a stark enough picture of the potential downside of investing, and she was therefore completely unprepared to make an informed decision about the risk she was taking. Is she a victim? No. She is responsible for her own decisions and lack of research. Do I feel sorry for her? Absolutely. She is a textbook example of the type of buyer that I’ve oft told “I don’t think you should buy an investment property in Austin. You’re not financially prepared to make the purchase or survive the expenses required to stay afloat. Sorry, but I can’t help you“.

If you can’t afford a 20% down payment, and if you don’t have the equivalent of 6 month’s rent held back in cash reserves to survive turnovers or unexpected repairs, and if you can’t handle potential $300 to $600 per month negative cash flow, and if you don’t have the personality and mental toughness to handle the ups and downs and bad news that may come at any time from your property manager, we don’t want to sell you an investment property because you don’t fit the profile of someone who should own one.

Again, from our Investing in Austin page:

If you aren’t fully prepared to accept the possibility that your investment property might produce negative cash flow, you shouldn’t be buying rental property in Austin TX and we shouldn’t be trying to sell you on the idea of doing so. Other Realtors will let you chase better cash flow out into the newer outskirt areas of Austin where you can buy a cheap home that will provide better numbers. We don’t do that because we ourselves won’t buy homes like that in those areas.

Each year, on the purchase anniversary date of our investors, Sylvia contacts them to offer a free market analysis to see if the home is appreciating. Most of our buyers purchased homes in South/SW Austin that have appreciated nicely, though their cashflow doesn’t look as good as it would have in Hutto.

We ourselves purchased our most recent rental property in Oak Hill in Feb 2007, and despite the bad news you read about, that particular home has increased in value by well over $20K (over 10%) the first year. The $300/mo. negative cash flow doesn’t bother me a bit given the $1,600/mo. value appreciation. I only want to own rental property that will attract a good, quality renter and that will appreciate in value. I don’t care about monthly cash flow.

On the other side of the coin, we just sold a home for a Round Rock investor which sold for $6,000 less than the investor paid for the property in 2006. That investment provided “break even” cash flow for two years as it went down in value. The investor lost money in the end. Which outcome would you prefer as an investor?

Bottom line, with property taxes and other expenses as they are in Austin, if you are not seeking first to purchase a home with appreciation potential, your investment strategy is doomed from the start, unless you get lucky. If you MUST have positive cash flow, make a 40% downpayment. Otherwise, stick to stocks and mutual funds.

Here is a link to the Statesman article.
Here is a link to a blog article I wrote Jan 2007 entitled “Why I Just Passed on a Positive Cash Flow Investment Property in Austin” which further illustrates the investment philosophy followed by me and Sylvia.

9 thoughts on “Dear Out of State Investors – We Told You So”

  1. Steve and Sylvia,

    As I ate my migas at my favorite breakfast place on Slaughter Ln. this morning and read today’s Statesman, I immediately remember the credit union fiasco in the late 1980s and how investors had run amock. Today’s article (and the previous article about the San Jose investor in Steiner Ranch) confirms that many of these players we’re cash flush and unprepared – again, running amock.

    I continue to enjoy your blog and again thank you for sharing your experience. Unfortunately, with the bailout of JP Morgan, Fannie Mae and other mortgage banks, we middle class Americans are again stuck with the costs of poor regulatory oversight and poor business ethics without any credit to our property and income taxes.

  2. Steve, we’re seeing much of the same thing here in Tucson; I still remember the busloads of Californians driving up and buying up half of a subdivision in a weekend.

    How does the Austin market look in regards to short sales and foreclosures?

  3. Hi Michael,

    The people I know who do short sales and pre-foreclosures say that they are increasing. These homes continue to remain out in the areas we’ve always avoided. The sad thing is, the owners in those areas who do in fact make their payments and hold on to their properties have their home values affected negatively by the proximity of the troubled homes.

    Occassionally there will be some short sale and foreclosures in the closer in areas, but not often. Those areas have generally appreciated enough to get the seller out from under the loan.

  4. Some of us Californians are still fine with our investments, and moreover have a real interest in the stability of the towns where we’ve invested!

    We’re San Franciscans who can’t afford to buy where we live. So starting about six years ago we started venturing into rental home purchases, including in Tucson and Austin, two of our favorite towns. We did that as a way to build equity and have cash flow in the future, plus potential places to live if and when the Big One hits.

    We treated these acquisitions as if these were for our primary residence, ie with 20% down and fixed rate loans, in stable neighborhoods with services and amenities to attract good tenants, and priced so that the rents could just about match expenses. Nothing fancy and definitely set up for deferred gains.

    As we were in our acquisition phase we encountered many different kinds of real estate professionals, and we ran the other way every time we met any “get rich quick” types or people who wanted to shove us on a bus to buy en masse or have us do a no-documentation loan with fuzzy terms.

    It is definitely a little nerve-wracking now as we observe the continuing fallout of the sub-prime mess, but we are still confident we made the right long-term choices and are very glad we got to work with people like Steve and Sylvia.

  5. Jennifer, sorry if I hit a nerve with lumping all ‘Californians’ together, I should have been more specific.

    I think it’s wonderful when homes are owned by people who actually care about the community and town where the home is located; driving through subdivisions here it’s quite apparent that those types of investors are sorely outnumbered.

    Let’s hope we get out of this mortgage mess without too much more trouble; from what I’ve been reading about lately the sub-prime loans were just the beginning now that the prime loans are about to start impacting us..

  6. I also live in San Francisco and have investment properties in South Austin.
    My wife and I also put 20% down on our properties and believe we are in good areas. We also take care of our properties and try to rent to good tenants. Some of these properties might be our primary home one day.

    Keep up he good work Steve and Sylvia. Hope to do business with you one day.

  7. The vast majority of out-of-state investors in Austin, including californians, were average folks looking to make a few bucks. It’s not a surprise tht the downturn has left some high and dry. The era of cheap financing and terms is will be over for many years now, possibly NEVER coming back again. Kudos to the Crosslands for being honest as well…


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